What Companies Should Do to Prepare for a Recession

Executive Summary

The question isn’t whether should prepare for a downturn; it’s how to prepare. The companies that emerged in best shape from the last recession lost nearly as much revenue as industry peers at the outset; the outliers were from a few sectors that didn’t experience the downturn as strongly. But by the time the recession had reached its lowest point in 2009, the resilients had increased their EBITDA by 10%, on average, while industry peers had lost nearly 15%. The resilients seem to have accomplished this by reducing operating costs earlier in the recession cycle, and more deeply. By the first quarter of 2008, the resilients had already cut operating costs 1% compared with the year before, even as their sector year-on-year costs were growing by a similar amount. The resilients maintained and expanded their cost lead as the recession moved toward its trough, improving their earnings advantage in seven out of the eight quarters during 2008 and 2009.

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The legendary ball-drop in Times Square at the end of 2018 marked a decade since one of the worst recessions in modern memory. Four miles away, nervous Wall Street-types wondered if it also marked the end of a long cycle of expansion. They were joined by a range of individual and institutional economic forecasters who are still arguing over whether we’ll see the start of another recession in 2019. Or in 2020. Or in 2021.

The question for these executives, then, isn’t whether to prepare, it’s how to prepare.

In the interest of finding lessons from past economic downturns and helping executives answer that question, we considered what it really means to be a resilient company in a recession. Specifically, we analyzed those businesses that managed to not only survive during the last downturn but actually thrive. We focused on companies that delivered exceptionally high total returns to shareholders (TRS) within their industries. These companies, which we dubbed the resilients, returned between 6% and 8% more in TRS (depending on the sector) than industry peers did. Their performance dipped less overall during the downturn, and they were able to significantly widen their leads in their respective industries during economic recovery.

What did the resilient companies do differently?

They weren’t protected from the market because they had better products or services. In fact, most of the resilient companies lost nearly as much revenue as industry peers during the recession; the outliers were from a few sectors that didn’t experience the downturn as strongly.

But by the time the recession had reached its lowest point in 2009, the resilients had increased their EBITDA by 10%, on average, while industry peers had lost nearly 15%. The resilients seem to have accomplished this by reducing operating costs earlier in the recession cycle, and more deeply. By the first quarter of 2008, the resilients had already cut operating costs 1% compared with the year before, even as their sector year-on-year costs were growing by a similar amount. The resilients maintained and expanded their cost lead as the recession moved toward its trough, improving their earnings advantage in seven out of the eight quarters during 2008 and 2009.

Their willingness to move early made the resilient companies far more likely to successfully weather economic shock. As the effects of the downturn became more and more apparent, resilient companies focused on building more flexibility into their investment-planning and operations in addition to pursuing continued earnings expansion. By the time the economy was in full-on recession, the resilients had reduced their debt by more than $1 for every $1 of total capital on their balance sheet. By contrast, non-resilient companies had added more than $3 of debt. The resilient companies accomplished this partly by divesting businesses and other assets more often than industry peers did: Our data show that 25% of all deals that resilients struck between 2007 and 2009 were divestitures, compared with 18% for non-resilients.

The upshot of all this is that resilients were entering the trough of the recession in much better shape than industry peers, with far more cash to bring into battle. Once the economy was on the upswing, resilients were able to use this cash to acquire the assets that industry peers were dumping in fire sales.

Apart from this emphasis on operating costs, resilient companies also focused on maintaining loyalty among high-value customers that were central to the company’s growth post-recession. Think of public examples like Hyundai’s Assurance program, which allowed customers to return cars if they lost their jobs. In some cases, the resilients in our database were forgoing revenues they could have earned through pricing changes. By contrast, industry peers were more likely to try and maintain revenue at any cost, applying price reductions haphazardly to products and services and sending mixed marketing messages.

What does this mean for future recessions?

The lessons revealed through our research are useful and enduring, but future recessions will look different from previous ones — and companies will need to adjust their strategies accordingly.

For a start, today’s CEOs are more constrained in their ability to cut costs. Activist investors, pressure from Wall Street, and other factors have already driven companies to become as lean as possible. Given the current debate on income inequality, combined with the increase in employee activism, cost cuts can create second-order consequences—hits to the brand, for instance, or political backlash, or reduced company morale. In this environment, “slashing costs” may end up being an inadequate tool for earnings growth.

Instead, we expect companies to increasingly turn to digital tools and advanced analytics to bolster productivity and drive growth. Some companies are already using advanced analytics to reduce quality issues and error rates in manufacturing plants. Other businesses are using digital platforms to enable self-service options for customers and to simplify the purchasing process.

We also expect companies to focus on many of the levers we’ve described: balance-sheet optimization, portfolio changes (divestments as well as acquisitions), and organizational simplification.

Main Street has it right: Even as the debate about “when” continues among economic forecasters, companies should begin to prepare themselves for the next recession. To assure some measure of resiliency, they should start now to assess the degree of exposure they have to slowdown, identify initiatives that can help to mitigate the exposure, and establish a “nerve center” to monitor progress on those initiatives.

As our research suggests, getting ahead relative to peers (even slightly) during recession gives companies an advantage that is tough to reverse when the economy is doing better.